Why Stock Markets May Be Lagging Indicators

Today Asia Confidential could talk about previously warning of Ben Bernanke tapering the taper and how U.S. government bonds and gold would rally as a consequence. Stroking the ego is a wonderful thing, and the financial world does it well, but it's not my thing. Alternatively, I could talk of what's going to happen to markets from here - but you can find plenty of that elsewhere.

No, instead, I'd like to delve deeper because there are some nagging questions from the past week's events. Why do stock markets remain at or near record-highs yet it doesn't feel like that to most people? Why the seemingly large gap between stock market and economic performance? Why are markets so dependent on the words of central bankers with dubious track records? And why did almost all financial analysts and pundits get it so wrong on the taper?

There are lots of seemingly simple answers to these questions. Central bank money printing, growing government debt loads, conspiracies between central banks and financiers, to name a few. While they have a place, none of them appear to provide a comprehensive explanation as to what's driving markets right now.

What does then, you ask? Well, the growing study of socionomics may give us some clues. Socionomics suggests social mood - what happens in society as expressed in the arts, music, mores, fashion and so on - drives stock markets which in turn drives economies. Put another way, what happens in society is a lead indicator for market price action. This theory turns conventional wisdom - purporting that economies drive stock markets and social mood - on its head.

Think about it. The biggest market crisis of late has been in India. For several years prior to the crisis, there were countless high-profile corruption cases, vast and growing movements against wealth inequality and several disturbing rape cases which caught the world's attention. Arguably, they reflected deepening divisions within society. That all happened prior to the crash in India's stock, bond and currency markets. Socionomics suggests that wasn't an accident.

And turn to today. In the U.S., there was the Tea Party movement post-crisis, Occupy Wall Street, then the fall of social icons such as Lance Armstrong, and now a spate of mass murders. In Europe, societal divisions have been clear yet have calmed at the least for the moment. In Asia, you have deep unease in Australia despite a healthy economy vis-à-vis the rest of the world, which led to the downfall of the government in the recent election. And then there's the Middle East, where the push for regime change grows and a broader war seems more likely than not.

Do these things signal a darker turn for markets in the not-too-distant future? I'm not sure. But perhaps it's worth your while paying as much attention to what's happening around you as to the words of the world's central bankers.

What the heck is socionomics?Turn on the television to CNBC and you'll hear endless chatter about the world's economies. Every data point and every news event is analysed and analysed again. And actions in stock markets are explored too. The price action of the S&P 500, the technicals behind a certain stock, the impact of events on certain sectors and so on.

The assumption behind these discussions is that economies drives stock markets, or conversely that stock markets lead economies. These things are drilled into MBA students and throughout the financial profession.

Socionomics says these discussion miss a key element. In fact, that the cause and effect implied is all wrong. The theory says that social mood drives human action, which drives stock markets, economies and much more. If people are feeling increasingly optimistic, they'll increase their productivity, which results in improved GDP. They'll also be more inclined to invest money in risk assets such as stock markets. In other words, social mood is a lead indicator for market risk appetite.

Fine, you might say - but how do you determine social mood? You can quantify earnings, economic performance and subsequent stock market performance, but how about social mood? Well there are socionomics followers who model trends in finance, macroeconomics, demographics, entertainment, fashion and other areas, to quantify such things.

The most famous follower is its inventor: Robert Prechter. This guy is better known as the leading proponent of the Elliot Wave Principle. Prechter suggests the Elliot Wave can also be applied to patterns of social mood.

Problems with common market indicatorsFor some of you, this may be heady stuff as it goes against everything you've been taught. And you may be dismissive as a result. So let's look at some of the common indicators used to forecast stock market action and how they may not be as predictive as many believe.

For instance, the theory that improving economies lead to better stock markets. This is conventional wisdom which every major academic study has contradicted. Every U.S. recession bar one over the past century has followed a downturn in stock markets. A lead indicator for stock markets, the economy is not.

How about demographics, then? There are many proponents of demographics driving stock markets. Best selling author, Harry Dent, is the most famous even though he's been far more wrong than right on his market calls. Trust me, he's made more money from his books than the market.

Anyhow, it's true that demographics in the U.S. line up well with stock market patterns since 1950. But before that, the data doesn't correlate well at all and the theory is questionable as a consequence.

How about war and peace then? Surely, war is bad for stock markets and peace is good? Not necessarily. The evidence is contradictory on this point. The Revolutionary War occurred as stock markets fell in the UK. During World War One, stock markets rose and then fall. World War Two saw the opposite happen.

There may be an alternative explanation for some of the above though. As mentioned earlier, an improved social mood can drive increased productivity and economic expansion. It can also lead to increased birth rates ie. happy people make for happy bedrooms. And of course, war and peace are largely determined by societal tensions rising or receding.

Back to the presentTying this back to markets today, it seems there's a lot of confusion about there being rising stock markets in the face of disappointing economic performance, widening gaps between rich and poor as well as widespread public disenchantment. The bulls argue that markets are a lead indicator and economies and the public mood will follow. The bears sneer and point to printed money driving higher markets.

But the bulls struggle to explain why the rising stock market is a sustainable trend. Improving earnings? Improving economies? There's little evidence of either. Meanwhile, the bears struggle to explain the reasons behind printed money making its way into stock markets rather than under a proverbial mattress.

It seems to this author that deepening global tensions may have something to say about the apparent contradictions in today's markets. And to point us to what may lay ahead.

In the U.S., you've had broad-based lynching of bankers and oil companies since the crisis. The rise of the Tea Party and Occupy Wall Street Movements. The fall of sporting icons such as Tiger Woods and Lance Armstrong. Horror movies have been making a comeback. Not to mention the increasing incidences of mass murders of late.

In Europe, you've had extraordinary youth unemployment, rising social tensions, overthrow of governments, political divisions threatening to undo the EU, the likes of Cyprus stealing bank deposits and the list goes on.

And in our neighbourhood of Asia, I've mentioned the depressing social mood in India, well before the recent currency crisis. In China, disgust at Communist Party corruption and the ostentatious display of wealth by party officials and businessmen has been apparent for several years. And it may explain the terrible performance of China's stock market, still down more than 60% from the 2007 peak.

In Australia, a rising stock market, still strong economy particularly when compared to other developed world countries and a rebound in already ludicrously priced housing still can't satisfy the locals. Consumer and business confidence remains low, evidenced by the Labor government being unceremoniously dumped in a recent election.

And let's not forget the Middle East, where several authoritarian regimes in power for decades have made way for comparatively weak military and civilian rule. And the threat of civil wars or worse, seems a matter of when, not if.

If socionomics is right, these things point to an uncertain future for markets. That the phases of increasing divisions and conflict since 2008 portend something worse ahead.

Extrapolating socionomics to the past week's events, what explains the hero-worship of Ben Bernanke and his cohort of central bankers? I'm not certain but my guess is that public disenchantment and confusion would correlate pretty well with historical episodes of hero-worship. It may also go some way to explaining the herd-like behaviour of financial analysts and commentators, almost all of whom called the taper, or non-taper, incorrectly. This kind of hero worship has a habit of turning around pretty quickly though too.

In sum, don't take the stock market at face value. Or central bankers, for that matter. Look around you and observe key social trends. What you observe could well be a precursor to future market action.